Commentary

Euro-crisis dilemma: austerity vs. stimulus

Commentary: Euro zone needs a clear, coordinated approach

By

MarkMalloch-Brown

LONDON (MarketWatch) — Spanish Prime Minister Mariano Rajoy has reopened a debate as old as the euro crisis or, indeed, debt crises themselves: Cut spending to reduce public deficits or spend to stimulate growth.

FTI Consulting

Mark Malloch-Brown.

This time, the terms of the discussion are muddied by the fact that a new right-of-center government has reported a yawning deficit to Brussels, more in sorrow than pleasure blaming it on its predecessor’s having cooked the books. Nevertheless it has preferred to cut only to a whopping deficit of 5.8% instead of the 4.4% originally proposed by the prime minister, rather than further deflate an economy that already has 23% unemployment. (Editor’s note: Spain eventually cut its target to 5.3% after bring pressured by euro-zone ministers.)

Through roles as an adviser to governments, at the top of international organizations and as a government minister myself, I have witnessed my share of international debt crises and how they are managed. Until 2008 Europe’s recent role had been a lot of advice, much of it unsolicited, about how other people in other parts of the world should manage their debt crises. So Latin Americans, Asians, Africans and then Eastern Europeans were for the most part urged to tighten their belts and pay up.

Occasionally imagination and statesmanship broke through, and a major program of debt relief for highly indebted poor countries would be introduced, as, for example, in Africa in the late 1990s. Europe was a real leader in making this World Bank–sponsored program happen. But, for the most part, the unthinking orthodoxy was this: When in doubt, cut public spending.

This approach almost met a controversial end in the 1997 Asian financial crisis, when a series of weak governments in that region were chided into perhaps unnecessarily recessionary policies as the price of Western financial support. It caused huge, and still lingering, resentment and led Asian governments to build up huge foreign-exchange reserves of their own so that they would never again have to lose face and bow to Western demands of this kind. There was even angry talk for a time of setting up an Asian Monetary Fund to allow Asian countries to bypass the IMF.

By contrast, a little earlier I had watched close up a Mexican financial crisis where a new president, Ernesto Zedillo, had to struggle to stabilize an economy saddled with heavy dollar-denominated commercial borrowings at a time when the peso was collapsing. In this case, a forceful period of adjustment imposed by Zedillo was supported by extraordinary leadership from a small group of officials in Washington, in the Clinton administration and the IMF. They put together a rescue package despite the opposition of Congress. It was quickly paid back with interest by Mexico, and the ground was laid for Mexico’s most successful period of growth and economic transformation. Related item in The Trading Deck: What the U.S. could learn from Mexico, by Jon Markman, plus more Trading Deck market analysis and investing strategy.

So it’s not a binary choice of cut or spend but rather a coherent sequence of when to do each so it is effectively coordinated internationally in such a way that everybody’s actions are not counteracting each other’s. For that to happen, it needs strong international leadership and coordination.

After a good coordinated start in 2008, the U.S. stimulated its economy, as did the U.K., until a midterm election in the former and a change of government in the latter threw spending into reverse (or sort of, as the spending impetus has run well ahead of the politicians’ rhetorical promises to cut). Germany, of course, has been a born-again budget-balancing stalwart even as those around it in continental Europe have chopped and changed.

It is this kind of confusion that markets punish and that prolongs economic crises.

The lesson of a lifetime in this kind of work has convinced me what matters more than the specifics of economic medicine — which will always be a matter of at least as many opinions as there are economists — is to set a line with your international partners and stick to it. Markets respect a clear narrative consistently implemented.

Walk the talk. When it happens, confidence comes back, and economies recover. The euro zone will continue to founder until it finds that kind of strong leadership, clear line and coordinated approach. In the meantime, Spain’s Rajoy cannot go one way and others another. We cut and swim together, or spend and swim together. If we do different combinations of each, we all sink.

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